SAN JOSE, Calif., Oct. 27, 2016 (GLOBE NEWSWIRE) — Heritage Commerce Corp (Nasdaq:HTBK), the holding company (the “Company”) for Heritage Bank of Commerce (the “Bank”), today reported net income increased 96% to $6.8 million, or $0.18 per average diluted common share, for the third quarter of 2016, compared to $3.5 million, or $0.10 per average diluted common share for the third quarter of 2015, and decreased 7% from $7.3 million, or $0.19 per average diluted common share for the second quarter of 2016. The second quarter of 2016 included a $1.0 million pre-tax gain from company-owned life insurance.

For the nine months ended September 30, 2016, net income was a record $20.2 million, or $0.53 per average diluted common share, an increase of 67% from $12.1 million, or $0.36 per average diluted common share, for the nine months ended September 30, 2015. All results are unaudited and the 2015 balances include the costs from the acquisition of Focus Business Bank (“Focus”) which was completed on August 20, 2015 (the “acquisition date”).

“We achieved record year-to-date earnings, along with strong third quarter 2016 earnings of $6.8 million,” said Walter Kaczmarek, President and Chief Executive Officer. “Deposits grew by $256.6 million, or 13% year-over-year, and the increased liquidity was invested in lower yielding funds at the Federal Reserve Bank. Asset quality was sound with nonperforming assets to total assets at 0.19%.”

“The strength of our Company continues to be driven by the commitment of our employees. Their hard work and dedication allow us to continue serving our clients and invest in the future of our franchise,” continued Mr. Kaczmarek. “As demonstrated by our financial results, we are building a significant and well-diversified community business bank in Northern California.”

Third Quarter 2016 Highlights (as of, or for the period ended September 30, 2016, except as noted):

Diluted earnings per share totaled $0.18 for the third quarter of 2016, compared to $0.10 for the third quarter of 2015, and $0.19 for the second quarter of 2016. Diluted earnings per share totaled $0.53 for the first nine months of 2016, compared to $0.36 per diluted share for the first nine months of 2015.

The return on average tangible assets was 1.13%, and the return on average tangible equity was 13.06%, for the third quarter of 2016, compared to 0.71% and 7.46%, respectively, for the third quarter of 2015, and 1.28% and 14.68%, respectively, for the second quarter of 2016. The return on average tangible assets was 1.16%, and the return on average tangible equity was 13.45%, for the first nine months of 2016, compared to 0.93% and 9.22%, respectively, for the first nine months of 2015.

The second quarter of 2016 included a $1.0 million pre-tax gain from company-owned life insurance. The 2015 balances included pre-tax acquisition, severance and retention costs incurred by the Company related to the Focus transaction totaling $2.9 million for the third quarter of 2015, and $3.4 million for the first nine months of 2015.

Net interest income increased 17% to $23.0 million for the third quarter of 2016, compared to $19.7 million for the third quarter of 2015, and increased 1% from $22.7 million for the second quarter of 2016. For the first nine months of 2016, net interest income increased 26% to $68.1 million, compared to $54.2 million for the first nine months of 2015.

For the third quarter of 2016, the fully tax equivalent (“FTE”) net interest margin contracted 29 basis points to 4.10% from 4.39% for the third quarter of 2015, primarily due to lower yields on loans and securities. The net interest margin contracted 17 basis points for the third quarter of 2016, from 4.27% for the second quarter of 2016, primarily due to higher average balances of lower yielding funds at the Federal Reserve Bank, and a lower yield on securities. For the first nine months of 2016, the net interest margin declined 35 basis points to 4.19%, compared to 4.54% for the first nine months of 2015, primarily due to higher average balances of lower yielding funds at the Federal Reserve Bank, and lower yields on loans and securities, which was partially offset by an increase in the accretion of the loan purchase discount income from the Focus transaction.

The accretion of the loan purchase discount in loan interest income from the Focus transaction was $299,000 for the third quarter of 2016, compared to $262,000 for the third quarter of 2015, and $276,000 for the second quarter of 2016. The accretion of the loan purchase discount in loan interest income from the Focus transaction was $1.1 million for the first nine months of 2016, compared to $262,000 for the first nine months of 2015. The total purchase discount on non-impaired loans from the Focus loan portfolio was $4.6 million at the acquisition date, of which $2.5 million has been accreted to loan interest income from the acquisition date through September 30, 2016.

Loans (excluding loans‑held‑for‑sale) increased $117.8 million, or 9%, to $1.45 billion at September 30, 2016, compared to $1.33 billion at September 30, 2015, which included an increase of $68.5 million, or 5% in the Company’s legacy portfolio, and $49.3 million of purchased residential mortgage loans at September 30, 2016. Loans decreased $13.9 million, or 1%, at September 30, 2016, compared to $1.46 billion at June 30, 2016, primarily due to a net $15.3 million decrease in land and construction loans as a result of the pay-off of $29.7 million in loans from the sale of projects at completion, and a net $7.5 million decrease in commercial real estate loans from $13.9 million in pay-offs, partially offset by an increase of $16.4 million in purchased residential mortgage loans.

Nonperforming assets (“NPAs”) were $4.8 million, or 0.19% of total assets, at September 30, 2016, compared to $5.9 million, or 0.26% of total assets, at September 30, 2015, and $4.7 million, or 0.20% of total assets, at June 30, 2016.

Classified assets were $18.7 million, or 0.74% of total assets, at September 30, 2016, compared to $18.0 million, or 0.79% of total assets, at September 30, 2015, and $22.8 million, or 0.96% of total assets, at June 30, 2016.

Net charge-offs totaled $134,000 for the third quarter of 2016, compared to net recoveries of $281,000 for the third quarter of 2015, and net recoveries of $112,000 for the second quarter of 2016.

There was a $245,000 provision for loan losses for the third quarter of 2016, compared to a $301,000 credit provision for loan losses for the third quarter of 2015, and a $351,000 provision for loan losses for the second quarter of 2016. There was a $997,000 provision for loan losses for the nine months ended September 30, 2016, compared to a $339,000 credit provision for loan losses for the nine months ended September 30, 2015.

The allowance for loan losses (“ALLL”) was 1.38% of total loans at September 30, 2016, compared to 1.41% at September 30, 2015, and 1.36% at June 30, 2016. The ALLL to total nonperforming loans was 445.55% at September 30, 2016, compared to 340.49% at September 30, 2015, and 456.90% at June 30, 2016.

Total deposits increased $256.6 million, or 13%, to $2.22 billion at September 30, 2016, compared to $1.96 billion at September 30, 2015, and increased $144.9 million, or 7%, from $2.07 billion at June 30, 2016. Deposits excluding all time deposits and CDARS deposits increased $291.2 million, or 17%, to $1.98 billion at September 30, 2016, from $1.69 billion at September 30, 2015, and increased $166.0 million, or 9%, from $1.81 billion at June 30, 2016.

The Company’s consolidated capital ratios exceeded regulatory guidelines and the Bank’s capital ratios exceeded the regulatory guidelines for a well-capitalized financial institution under the Basel III regulatory requirements at September 30, 2016.

Well-capitalized

Fully Phased-in

Financial

Basel III

Institution

Minimal

Heritage

Heritage

Basel III

Requirement(1)

Commerce

Bank of

Regulatory

Effective

CAPITAL RATIOS

Corp

Commerce

Guidelines

January 1, 2019

Total Risk-Based

12.7

%

12.6

%

10.0

%

10.5

%

Tier 1 Risk-Based

11.6

%

11.4

%

8.0

%

8.5

%

Common Equity Tier 1 Risk-Based

11.6

%

11.4

%

6.5

%

7.0

%

Leverage

8.9

%

8.7

%

5.0

%

4.0

%

(1) Requirements for both the Company and the Bank include a 2.5% capital conservation buffer, except the leverage ratio.

Operating Results

Net interest income increased 17% to $23.0 million for the third quarter of 2016, compared to $19.7 million for the third quarter of 2015, and increased 1% from $22.7 million for the second quarter of 2016. Net interest income increased 26% to $68.1 million for the nine months ended September 30, 2016, compared to $54.2 million for the nine months ended September 30, 2015. Net interest income increased for the third quarter and first nine months of 2016, compared to the respective periods in 2015, primarily due to organic growth in the loan portfolio, the accretion of the loan purchase discount into interest income from the Focus transaction, and an increase in the average balance of investment securities.

For the third quarter of 2016, the net interest margin (FTE) contracted 29 basis points to 4.10% from 4.39% for the third quarter of 2015, primarily due to lower yields on loans and securities. The net interest margin contracted 17 basis points for the third quarter of 2016, from 4.27% for the second quarter of 2016, primarily due to higher average balances of lower yielding funds at the Federal Reserve Bank, and a lower yield on securities. For the first nine months of 2016, the net interest margin decreased 35 basis points to 4.19%, compared to 4.54% for the first nine months of 2015, primarily due to higher average balances of lower yielding funds at the Federal Reserve Bank, and lower yields on loans and securities, which was partially offset by an increase in the accretion of the loan purchase discount from the Focus transaction.

There was a $245,000 provision for loan losses for the third quarter of 2016, compared to a $301,000 credit provision for loan losses for the third quarter of 2015, and a $351,000 provision for loan losses for the second quarter of 2016. There was a $997,000 provision for loan losses for the nine months ended September 30, 2016, compared to a $339,000 credit provision for loan losses for the nine months ended September 30, 2015.

Noninterest income increased to $2.3 million for the third quarter of 2016, compared to $2.1 million for the third quarter of 2015, and decreased from $3.7 million for the second quarter of 2016. The decrease in noninterest income for the third quarter of 2016, compared to the second quarter of 2016, was primarily due to a $1.0 million gain from company owned life insurance and a $347,000 gain on sales of securities in the second quarter of 2016. For the nine months ended September 30, 2016, noninterest income was $8.6 million, compared to $6.2 million at September 30, 2015. The increase in noninterest income for the first nine months of 2016, compared to the first nine months of 2015, was primarily due to a $1.0 million gain on proceeds from company owned life insurance and higher gains on sales of securities.

The Company maintains life insurance policies for some directors and officers that are subject to split-dollar life insurance agreements, which continue after the participant’s employment termination or retirement. During the second quarter of 2016, the Company received death benefit proceeds of $3.1 million from the life insurance policy of a former officer of a bank acquired by the Company. The cash surrender value of the policy was $2.1 million, which resulted in a gain on proceeds from company owned life insurance of $1.0 million.

Total noninterest expense for the third quarter of 2016 was $14.3 million, compared to $16.4 million for the third quarter of 2015, and $14.4 million for the second quarter of 2016. The decrease in noninterest expense in the third quarter of 2016, compared to the third quarter of 2015, was primarily due to pre-tax acquisition, severance and retention costs incurred by the Company related to the Focus transaction totaling $2.9 million for the third quarter of 2015. Noninterest expense for the nine months ended September 30, 2016 increased to $43.4 million, compared to $41.3 million for the nine months ended September 30, 2015, primarily due to additional employees retained from Focus and an increase in amortization of the core deposit intangible assets as a result of the Focus acquisition, annual salary increases, newly hired employees and higher professional fees, partially offset by $3.4 million of pre-tax acquisition, severance and retention costs incurred by the Company for the first nine months of 2015. Professional fees were significantly lower in the first nine months of 2015 due to recoveries of legal fees on problem loans that were paid off. Full time equivalent employees were 264 at September 30, 2016, 272 at September 30, 2015, and 268 at June 30, 2016.

The efficiency ratio for the third quarter of 2016 was 56.37%, compared to 75.49% for the third quarter of 2015, and 54.47% for the second quarter of 2016. The efficiency ratio for the nine months ended September 30, 2016 was 56.55%, compared to 68.47% for the nine months ended September 30, 2015. The higher efficiency ratio in the third quarter of 2015 and nine months ended September 30, 2015 was primarily due to one-time Focus acquisition, severance and retention costs. Excluding the one-time Focus acquisition, severance and retention costs, the efficiency ratio was 62.32% for the third quarter of 2015, and 62.76% for the nine months ended September 30, 2015.

Income tax expense for the third quarter of 2016 was $4.1 million, compared to $2.2 million for the third quarter of 2015, and $4.4 million for the second quarter of 2016. The effective tax rate for the third quarter of 2016 was 37.5%, compared to 38.6% for the third quarter of 2015, and 37.5% for the second quarter of 2016. The effective tax rate for the third quarter of 2015 was higher primarily due to the impact of non-deductible merger related expenses. Income tax expense for the nine months ended September 30, 2016 was $12.2 million, compared to $7.3 million for the nine months ended September 30, 2015. The effective tax rate for the nine months ended September 30, 2016 was 37.6%, compared to 37.7% for the nine months ended September 30, 2015. The difference in the effective tax rate for the periods reported, compared to the combined Federal and state statutory tax rate of 42%, is primarily the result of the Company’s investment in life insurance policies whose earnings are not subject to taxes, tax credits related to investments in low income housing limited partnerships (net of low income housing investment losses), and tax-exempt interest income earned on municipal bonds.

Balance Sheet Review, Capital Management and Credit Quality

Total assets were $2.53 billion at September 30, 2016, compared to $2.26 billion at September 30, 2015, and $2.38 billion at June 30, 2016.

The investment securities available-for-sale portfolio totaled $370.0 million at September 30, 2016, compared to $257.4 million at September 30, 2015, and $390.4 million at June 30, 2016. At September 30, 2016, the Company’s securities available-for-sale portfolio was comprised of $352.6 million agency mortgage-backed securities (all issued by U.S. Government sponsored entities), $16.4 million of single entity issue trust preferred securities, and $1.0 million of corporate bonds. The pre-tax unrealized gain on securities available-for-sale at September 30, 2016 was $8.0 million, compared to a pre-tax unrealized gain on securities available-for-sale of $4.5 million at September 30, 2015, and a pre-tax unrealized gain on securities available-for-sale of $7.7 million at June 30, 2016.

At September 30, 2016, investment securities held-to-maturity totaled $202.4 million, compared to $111.0 million at September 30, 2015, and $210.2 million at June 30, 2016. At September 30, 2016, the Company’s securities held-to-maturity portfolio, at amortized cost, was comprised of $90.8 million tax-exempt municipal bonds, and $111.6 million agency mortgage-backed securities.

Loans (excluding loans‑held‑for‑sale) increased $117.8 million, or 9%, to $1.45 billion at September 30, 2016, compared to $1.33 billion at September 30, 2015, which included an increase of $68.5 million, or 5% in the Company’s legacy portfolio, and $49.3 million of purchased residential mortgage loans at September 30, 2016. Loans decreased $13.9 million, or 1%, at September 30, 2016, compared to $1.46 billion at June 30, 2016, primarily due to a net $15.3 million decrease in land and construction loans as a result of the pay-off of $29.7 million in loans from the sale of projects at completion, and a net $7.5 million decrease in commercial real estate loans from $13.9 million in pay-offs, partially offset by an increase of $16.4 million in purchased residential mortgage loans.

The loan portfolio remains well-diversified with commercial and industrial (“C&I”) loans accounting for 42% of the loan portfolio at September 30, 2016, which included $47.8 million of factored receivables at Bay View Funding. Commercial real estate loans accounted for 42% of the total loan portfolio, of which 43% were owner-occupied by businesses. Consumer and home equity loans accounted for 7% of total loans, land and construction loans accounted for 6% of total loans, and residential mortgage loans accounted for the remaining 3% of total loans at September 30, 2016. C&I line usage was 41% at September 30, 2016, compared to 42% at June 30, 2016.

During the second and third quarters of 2016, the Company purchased jumbo single family residential mortgage loans totaling $51.6 million, all of which are domiciled in California. The average loan principal amount is approximately $834,000, and the weighted average yield on the portfolio is 3.00%, net of servicing fees to the servicer. Residential mortgages outstanding at September 30, 2016 totaled $49.3 million, compared to $32.9 million at June 30, 2016.

The yield on the loan portfolio was 5.60% for the third quarter of 2016, compared to 5.70% for the third quarter of 2015, and 5.60% for the second quarter of 2016. The yield on the loan portfolio was 5.61% for the nine months ended September 30, 2016, compared to 5.69% for the nine months ended September 30, 2015. The decrease in the yield on the loan portfolio for the third quarter of 2016 and nine months ended September 30, 2016, compared to the respective periods in 2015, was primarily due to a decrease in the proportion of loans in the higher yielding Bay View Funding factored receivables portfolio relative to the addition of the Focus loans and growth in the Company’s legacy portfolio, partially offset by an increase in the accretion of the loan purchase discount into loan interest income from the Focus transaction.

At September 30, 2016, NPAs were $4.8 million, or 0.19% of total assets, compared to $5.9 million, or 0.26% of total assets, at September 30, 2015, and $4.7 million, or 0.20% of total assets, at June 30, 2016. At September 30, 2016, the NPAs included no loans guaranteed by the SBA. Foreclosed assets were $292,000 at September 30, 2016, compared to $393,000 at September 30, 2015, and $313,000 at June 30, 2016. The following is a breakout of NPAs at the periods indicated:

End of Period:

NONPERFORMING ASSETS

September 30, 2016

June 30, 2016

September 30, 2015

(in $000’s, unaudited)

Balance

% of Total

Balance

% of Total

Balance

% of Total

Commercial and industrial loans

$

3,570

75

%

$

504

11

%

$

947

16

%

Commercial real estate loans

440

9

%

2,849

61

%

3,075

52

%

Foreclosed assets

292

6

%

313

7

%

393

7

%

Home equity and consumer loans

278

6

%

760

16

%

316

5

%

Land and construction loans

201

4

%

207

4

%

492

8

%

SBA loans

7

0

%

40

1

%

673

12

%

Total nonperforming assets

$

4,788

100

%

$

4,673

100

%

$

5,896

100

%

Classified assets were $18.7 million at September 30, 2016, compared to $18.0 million at September 30, 2015, and $22.8 million at June 30, 2016. Classified assets include Small Business Administration (“SBA”) guarantees of $10,000 at September 30, 2016, $0 at September 30, 2015, and $14,000 at June 30, 2016.

The following table summarizes the allowance for loan losses:

For the Quarter Ended

For the Nine Months Ended

ALLOWANCE FOR LOAN LOSSES

September 30,

June 30,

September 30,

September 30,

September 30,

(in $000’s, unaudited)

2016

2016

2015

2016

2015

Balance at beginning of period

$

19,921

$

19,458

$

18,757

$

18,926

$

18,379

Provision (credit) for loan losses during the period

245

351

(301

)

997

(339

)

Net recoveries (charge-offs) during the period

(134

)

112

281

109

697

Balance at end of period

$

20,032

$

19,921

$

18,737

$

20,032

$

18,737

Total loans

$

1,450,176

$

1,464,114

$

1,132,405

$

1,450,176

$

1,332,405

Total nonperforming loans

$

4,496

$

4,360

$

5,503

$

4,496

$

5,503

Allowance for loan losses to total loans

1.38

%

1.36

%

1.41

%

1.38

%

1.41

%

Allowance for loan losses to total nonperforming loans

445.55

%

456.90

%

340.49

%

445.55

%

340.49

%

The ALLL at September 30, 2016 was 1.38% of total loans, compared to 1.41% at September 30, 2015, and 1.36% at June 30, 2016. The ALLL to total nonperforming loans was 445.55% at September 30, 2016, compared to 340.49% at September 30, 2015, and 456.90% at June 30, 2016.

Total deposits increased $256.6 million, or 13%, to $2.22 billion at September 30, 2016, compared to $1.96 billion at September 30, 2015, and increased $144.9 million, or 7%, at September 30, 2016, compared to $2.07 billion at June 30, 2016. Deposits excluding all time deposits and CDARS deposits increased $291.2 million, or 17%, to $1.98 billion at September 30, 2016, from $1.69 billion at September 30, 2015, and increased $166.0 million, or 9%, from $1.81 billion at June 30, 2016.

The total cost of deposits remained the same at 0.15 % for the third quarter of 2016, the third quarter of 2015, and the second quarter of 2016. The total cost of deposits was also at 0.15% for the nine months ended September 30, 2016 and September 30, 2015.

Tangible equity was $208.3 million at September 30, 2016, compared to $194.2 million at September 30, 2015, and $204.1 million at June 30, 2016. Tangible book value per common share was $5.49 at September 30, 2016, compared to $5.44 at September 30, 2015, and $5.72 at June 30, 2016. There was no Series C Preferred Stock outstanding at September 30, 2016, compared to 21,004 shares of Series C Preferred Stock outstanding at September 30, 2015 and June 30, 2016. Pro forma tangible book value per common share, assuming the outstanding Series C Preferred Stock was converted into common stock, was $5.15 at September 30, 2015, and $5.39 at June 30, 2016.

On September 12, 2016, the Company entered into Exchange Agreements with Castle Creek Capital Partners IV, LP , Patriot Financial Partners, L.P. and Patriot Financial Partners Parallel, L.P. (collectively “Preferred Stockholders”) providing for the exchange of 21,004 shares of the Series C Preferred Stock, for 5,601,000 shares of the Company’s common stock. The exchange ratio was equal to the equivalent number of shares the Preferred Stockholders would have received upon conversion of the Series C Preferred Stock.

Accumulated other comprehensive loss was ($2.0) million at September 30, 2016, compared to ($2.0) million at September 30, 2015, and ($2.1) million at June 30, 2016. The unrealized gain on securities available-for-sale, net of taxes, included in accumulated other comprehensive loss was an unrealized gain of $4.7 million September 30, 2016, compared to $2.6 million at September 30, 2015, and $4.5 million at June 30, 2016. The components of accumulated other comprehensive loss, net of taxes, at September 30, 2016 include the following: an unrealized gain on available-for-sale securities of $4.7 million; the remaining unamortized unrealized gain on securities available-for-sale transferred to held-to-maturity of $342,000; a split dollar insurance contracts liability of ($3.6) million; a supplemental executive retirement plan liability of ($4.0) million; and an unrealized gain on interest-only strip from SBA loans of $639,000.

Heritage Commerce Corp, a bank holding company established in February 1998, is the parent company of Heritage Bank of Commerce, established in 1994 and headquartered in San Jose with full-service branches in Danville, Fremont, Gilroy, Hollister, Los Altos, Los Gatos, Morgan Hill, Pleasanton, Sunnyvale, and Walnut Creek. Heritage Bank of Commerce is an SBA Preferred Lender. Bay View Funding, a subsidiary of Heritage Bank of Commerce, is based in Santa Clara and provides business‑essential working capital factoring financing to various industries throughout the United States. For more information, please visit www.heritagecommercecorp.com.

Forward Looking Statement Disclaimer

These forward looking statements are subject to various risks and uncertainties that may be outside our control and our actual results could differ materially from our projected results. In addition, our past results of operations do not necessarily indicate our future results. The forward looking statements could be affected by many factors, including but not limited to: (1) local, regional, and national economic conditions and events and their impact on us and our customers; (2) changes in the financial performance or condition of the Company’s customers; (3) volatility in credit and equity markets and its effect on the global economy; (4) competition for loans and deposits and failure to attract or retain deposits and loans; (5) our ability to increase market share and control expenses; (6) our ability to develop and promote customer acceptance of new products and services in a timely manner; (7) risks associated with concentrations in real estate related loans; (8) other than temporary impairment charges to our securities portfolio; (9) an oversupply of inventory and deterioration in values of California commercial real estate; (10) a prolonged slowdown in construction activity; (11) changes in the level of nonperforming assets and charge offs and other credit quality measures, and their impact on the adequacy of the Company’s allowance for loan losses and the Company’s provision for loan losses; (12) the effects of and changes in trade, monetary and fiscal policies and laws, including the interest rate policies of the Federal Open Market Committee of the Federal Reserve Board; (13) changes in inflation, interest rates, and market liquidity which may impact interest margins and impact funding sources; (14) our ability to raise capital or incur debt on reasonable terms; (15) regulatory limits on Heritage Bank of Commerce’s ability to pay dividends to the Company; (16) changes in our capital management policies, including those regarding business combinations, dividends, and share repurchases, among others; (17) operational issues stemming from, and/or capital spending necessitated by, the potential need to adapt to industry changes in information technology systems, on which we are highly dependent; (18) the ability to keep pace with, and implement on a timely basis, technological changes; (19) the impact of cyber security attacks or other disruptions to the Company’s information systems and any resulting compromise of data or disruptions in service; (20) changes in the competitive environment among financial or bank holding companies and other financial service providers; (21) the effect and uncertain impact on the Company of the enactment of the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010 and the rules and regulations promulgated by supervisory and oversight agencies implementing the new legislation; (22) significant changes in applicable laws and regulations, including those concerning taxes, banking and securities; (23) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters; (24) the costs and effects of legal and regulatory developments, including resolution of legal proceedings or regulatory or other governmental inquiries, and the results of regulatory examinations or reviews; (25) the successful integration of the business, employees and operations of Focus Business Bank with the Company and our ability to achieve the projected synergies of this acquisition within the expected time frame; and (26) our success in managing the risks involved in the foregoing factors.

Member FDIC

For the Quarter Ended:

Percent Change From:

For the Nine Months Ended:

CONSOLIDATED INCOME STATEMENTS

September 30,

June 30,

September 30,

June 30,

September 30,

September 30,

September 30,

Percent

(in $000’s, unaudited)

2016

2016

2015

2016

2015

2016

2015

Change

Interest income

$

23,874

$

23,504

$

20,306

2

%

18

%

$

70,440

$

55,847

26

%

Interest expense

826

760

623

9

%

33

%

2,344

1,664

41

%

Net interest income before provision for loan losses

23,048

22,744

19,683

1

%

17

%

68,096

54,183

26

%

Provision (credit) for loan losses

245

351

(301

)

-30

%

181

%

997

(339

)

394

%

Net interest income after provision for loan losses

22,803

22,393

19,984

2

%

14

%

67,099

54,522

23

%

Noninterest income:

Service charges and fees on deposit accounts

798

783

748

2

%

7

%

2,348

2,086

13

%

Increase in cash surrender value of life insurance

428

440

429

-3

%

0

%

1,317

1,225

8

%

Servicing income

364

371

214

-2

%

70

%

1,106

819

35

%

Gain on sales of SBA loans

69

279

267

-75

%

-74

%

653

660

-1

%

Gain on proceeds from company owned life insurance

-

1,019

-

-100

%

N/A

1,019

-

N/A

Gain on sales of securities

-

347

-

-100

%

N/A

527

-

N/A

Other

653

421

408

55

%

60

%

1,616

1,366

18

%

Total noninterest income

2,312

3,660

2,066

-37

%

12

%

8,586

6,156

39

%

Noninterest expense:

Salaries and employee benefits

8,363

8,742

10,358

-4

%

-19

%

26,052

26,112

0

%

Occupancy and equipment

1,120

1,081

1,063

4

%

5

%

3,277

3,135

5

%

Professional fees

1,086

708

612

53

%

77

%

2,619

946

177

%

Other

3,727

3,850

4,386

-3

%

-15

%

11,414

11,119

3

%

Total noninterest expense

14,296

14,381

16,419

-1

%

-13

%

43,362

41,312

5

%

Income before income taxes

10,819

11,672

5,631

-7

%

92

%

32,323

19,366

67

%

Income tax expense

4,054

4,377

2,172

-7

%

87

%

12,157

7,292

67

%

Net income

6,765

7,295

3,459

-7

%

96

%

20,166

12,074

67

%

Dividends on preferred stock

(504

)

(504

)

(448

)

0

%

13

%

(1,512

)

(1,344

)

13

%

Net income available to common shareholders

6,261

6,791

3,011

-8

%

108

%

18,654

10,730

74

%

Undistributed earnings allocated to Series C preferred stock

(300

)

(576

)

(111

)

-48

%

170

%

(1,278

)

(706

)

81

%

Distributed and undistributed earnings allocated to common

shareholders

$

5,961

$

6,215

$

2,900

-4

%

106

%

$

17,376

$

10,024

73

%

PER COMMON SHARE DATA

(unaudited)

Basic earnings per share

$

0.18

$

0.19

$

0.10

-5

%

80

%

$

0.53

$

0.37

43

%

Diluted earnings per share

$

0.18

$

0.19

$

0.10

-5

%

80

%

$

0.53

$

0.36

47

%

Weighted average shares outstanding – basic

33,397,704

32,243,935

29,075,782

4

%

15

%

32,591,784

27,386,471

19

%

Weighted average shares outstanding – diluted

33,693,328

32,512,611

29,332,452

4

%

15

%

32,863,855

27,589,464

19

%

Common shares outstanding at period-end

37,915,736

32,294,063

32,076,505

17

%

18

%

37,915,736

32,076,505

18

%

Pro forma common shares outstanding at period-end, assuming

Series C preferred stock was converted into common stock

N/A

37,895,063

37,677,505

N/A

N/A

N/A

37,677,505

N/A

Book value per share

$

6.89

$

7.37

$

7.12

-7

%

-3

%

$

6.89

$

7.12

-3

%

Tangible book value per share

$

5.49

$

5.72

$

5.44

-4

%

1

%

$

5.49

$

5.44

1

%

Pro forma tangible book value per share, assuming Series C

preferred stock was converted into common stock

N/A

$

5.39

$

5.15

N/A

N/A

N/A

$

5.15

N/A

KEY FINANCIAL RATIOS

(unaudited)

Annualized return on average equity

10.38

%

11.58

%

6.41

%

-10

%

62

%

10.61

%

8.25

%

29

%

Annualized return on average tangible equity

13.06

%

14.68

%

7.46

%

-11

%

75

%

13.45

%

9.22

%

46

%

Annualized return on average assets

1.11

%

1.25

%

0.70

%

-11

%

59

%

1.13

%

0.92

%

23

%

Annualized return on average tangible assets

1.13

%

1.28

%

0.71

%

-12

%

59

%

1.16

%

0.93

%

25

%

Net interest margin

4.10

%

4.27

%

4.39

%

-4

%

-7

%

4.19

%

4.54

%

-8

%

Efficiency ratio

56.37

%

54.47

%

75.49

%

3

%

-25

%

56.55

%

68.47

%

-17

%

AVERAGE BALANCES

(in $000’s, unaudited)

Average assets

$

2,431,303

$

2,345,874

$

1,956,047

4

%

24

%

$

2,375,958

$

1,752,778

36

%

Average tangible assets

$

2,378,045

$

2,292,248

$

1,925,912

4

%

23

%

$

2,322,317

$

1,732,057

34

%

Average earning assets

$

2,263,997

$

2,172,349

$

1,805,801

4

%

25

%

$

2,198,178

$

1,622,605

35

%

Average loans held-for-sale

$

5,992

$

2,951

$

3,197

103

%

87

%

$

4,568

$

1,985

130

%

Average total loans

$

1,436,014

$

1,415,001

$

1,229,792

1

%

17

%

$

1,405,069

$

1,134,223

24

%

Average deposits

$

2,121,469

$

2,042,524

$

1,693,282

4

%

25

%

$

2,065,170

$

1,509,210

37

%

Average demand deposits – noninterest-bearing

$

842,565

$

780,116

$

652,529

8

%

29

%

$

800,049

$

578,117

38

%

Average interest-bearing deposits

$

1,278,904

$

1,262,408

$

1,040,753

1

%

23

%

$

1,265,121

$

931,093

36

%

Average interest-bearing liabilities

$

1,278,959

$

1,262,415

$

1,040,919

1

%

23

%

$

1,265,722

$

931,173

36

%

Average equity

$

259,395

$

253,430

$

214,105

2

%

21

%

$

253,862

$

195,731

30

%

Average tangible equity

$

206,137

$

199,804

$

183,970

3

%

12

%

$

200,221

$

175,010

14

%

End of Period:

Percent Change From:

CONSOLIDATED BALANCE SHEETS

September 30,

June 30,

September 30,

June 30,

September 30,

(in $000’s, unaudited)

2016

2016

2015

2016

2015

ASSETS

Cash and due from banks

$

39,838

$

30,820

$

28,691

29

%

39

%

Federal funds sold and interest-bearing

deposits in other financial institutions

304,554

128,024

364,247

138

%

-16

%

Securities available-for-sale, at fair value

369,999

390,435

257,410

-5

%

44

%

Securities held-to-maturity, at amortized cost

202,404

210,170

111,004

-4

%

82

%

Loans held-for-sale – SBA, including deferred costs

6,741

4,879

7,873

38

%

-14

%

Loans:

Commercial

606,281

610,385

554,169

-1

%

9

%

Real estate:

Commercial

612,030

619,539

606,819

-1

%

1

%

Land and construction

88,371

103,710

84,867

-15

%

4

%

Home equity

76,536

78,332

74,624

-2

%

3

%

Residential mortgages

49,255

32,852

-

50

%

N/A

Consumer

18,328

20,037

12,595

-9

%

46

%

Loans

1,450,801

1,464,855

1,333,074

-1

%

9

%

Deferred loan fees

(625

)

(741

)

(669

)

-16

%

-7

%

Total loans, net of deferred fees

1,450,176

1,464,114

1,332,405

-1

%

9

%

Allowance for loan losses

(20,032

)

(19,921

)

(18,737

)

1

%

7

%

Loans, net

1,430,144

1,444,193

1,313,668

-1

%

9

%

Company owned life insurance

59,193

58,765

59,549

1

%

-1

%

Premises and equipment, net

7,552

7,542

7,513

0

%

1

%

Goodwill

45,664

45,664

44,898

0

%

2

%

Other intangible assets

7,342

7,734

8,906

-5

%

-18

%

Accrued interest receivable and other assets

54,531

50,066

58,448

9

%

-7

%

Total assets

$

2,527,962

$

2,378,292

$

2,262,207

6

%

12

%

LIABILITIES AND SHAREHOLDERS’ EQUITY

Liabilities:

Deposits:

Demand, noninterest-bearing

$

889,075

$

834,590

$

758,440

7

%

17

%

Demand, interest-bearing

536,541

499,512

440,517

7

%

22

%

Savings and money market

555,156

480,677

490,572

15

%

13

%

Time deposits-under $250

57,718

60,761

65,626

-5

%

-12

%

Time deposits-$250 and over

169,485

182,591

174,703

-7

%

-3

%

Time deposits – brokered

3,000

6,079

24,150

-51

%

-88

%

CDARS – money market and time deposits

7,659

9,574

8,015

-20

%

-4

%

Total deposits

2,218,634

2,073,784

1,962,023

7

%

13

%

Borrowings

-

-

1,000

N/A

-100

%

Accrued interest payable and other liabilities

48,009

46,995

51,208

2

%

-6

%

Total liabilities

2,266,643

2,120,779

2,014,231

7

%

13

%

Shareholders’ Equity:

Series C preferred stock, net

-

19,519

19,519

-100

%

-100

%

Common stock

214,601

194,765

193,070

10

%

11

%

Retained earnings

48,726

45,371

37,366

7

%

30

%

Accumulated other comprehensive loss

(2,008

)

(2,142

)

(1,979

)

6

%

-1

%

Total shareholders’ equity

261,319

257,513

247,976

1

%

5

%

Total liabilities and shareholders’ equity

$

2,527,962

$

2,378,292

$

2,262,207

6

%

12

%

End of Period:

Percent Change From:

CREDIT QUALITY DATA

September 30,

June 30,

September 30,

June 30,

September 30,

(in $000’s, unaudited)

2016

2016

2015

2016

2015

Nonaccrual loans – held-for-investment

$

4,496

$

4,360

$

5,503

3

%

-18

%

Foreclosed assets

292

313

393

-7

%

-26

%

Total nonperforming assets

$

4,788

$

4,673

$

5,896

2

%

-19

%

Other restructured loans still accruing

$

137

$

141

$

183

-3

%

-25

%

Net (recoveries) charge-offs during the quarter

$

134

$

(112

)

$

(281

)

220

%

148

%

Provision (credit) for loan losses during the quarter

$

245

$

351

$

(301

)

-30

%

181

%

Allowance for loan losses

$

20,032

$

19,921

$

18,737

1

%

7

%

Classified assets

$

18,693

$

22,811

$

17,976

-18

%

4

%

Allowance for loan losses to total loans

1.38

%

1.36

%

1.41

%

1

%

-2

%

Allowance for loan losses to total nonperforming loans

445.55

%

456.90

%

340.49

%

-2

%

31

%

Nonperforming assets to total assets

0.19

%

0.20

%

0.26

%

-5

%

-27

%

Nonperforming loans to total loans

0.31

%

0.30

%

0.41

%

3

%

-24

%

Classified assets to Heritage Commerce Corp Tier 1

capital plus allowance for loan losses

8

%

10

%

8

%

-20

%

0

%

Classified assets to Heritage Bank of Commerce Tier 1

capital plus allowance for loan losses

8

%

10

%

8

%

-20

%

0

%

OTHER PERIOD-END STATISTICS

(in $000’s, unaudited)

Heritage Commerce Corp:

Tangible equity

$

208,313

$

204,115

$

194,172

2

%

7

%

Tangible common equity

$

208,313

$

184,596

$

174,653

13

%

19

%

Shareholders’ equity / total assets

10.34

%

10.83

%

10.96

%

-5

%

-6

%

Tangible equity / tangible assets

8.42

%

8.78

%

8.79

%

-4

%

-4

%

Tangible common equity / tangible assets

8.42

%

7.94

%

7.91

%

6

%

6

%

Loan to deposit ratio

65.36

%

70.60

%

67.91

%

-7

%

-4

%

Noninterest-bearing deposits / total deposits

40.07

%

40.24

%

38.66

%

0

%

4

%

Total risk-based capital ratio

12.7

%

12.3

%

12.3

%

3

%

3

%

Tier 1 risk-based capital ratio

11.6

%

11.2

%

11.2

%

4

%

4

%

Common Equity Tier 1 risk-based capital ratio

11.6

%

10.2

%

10.2

%

14

%

14

%

Leverage ratio

8.9

%

9.0

%

10.4

%

-1

%

-14

%

Heritage Bank of Commerce:

Total risk-based capital ratio

12.6

%

12.2

%

12.1

%

3

%

4

%

Tier 1 risk-based capital ratio

11.4

%

11.1

%

11.0

%

3

%

4

%

Common Equity Tier 1 risk-based capital ratio

11.4

%

11.1

%

11.0

%

3

%

4

%

Leverage ratio

8.7

%

8.9

%

10.2

%

-2

%

-15

%

For the Quarter Ended

For the Quarter Ended

September 30, 2016

September 30, 2015

Interest

Average

Interest

Average

NET INTEREST INCOME AND NET INTEREST MARGIN

Average

Income/

Yield/

Average

Income/

Yield/

(in $000’s, unaudited)

Balance

Expense

Rate

Balance

Expense

Rate

Assets:

Loans, gross(1)

$

1,442,006

$

20,312

5.60

%

$

1,232,989

$

17,713

5.70

%

Securities – taxable

497,821

2,401

1.92

%

244,313

1,670

2.71

%

Securities – tax exempt(2)

91,241

875

3.82

%

91,127

874

3.80

%

Other investments and interest-bearing

deposits in other financial institutions

232,929

592

1.01

%

237,372

355

0.59

%

Total interest earning assets(2)

2,263,997

24,180

4.25

%

1,805,801

20,612

4.53

%

Cash and due from banks

32,628

34,921

Premises and equipment, net

7,595

7,374

Goodwill and other intangible assets

53,258

30,135

Other assets

73,825

77,816

Total assets

$

2,431,303

$

1,956,047

Liabilities and shareholders’ equity:

Deposits:

Demand, noninterest-bearing

$

842,565

$

652,529

Demand, interest-bearing

515,296

259

0.20

%

326,922

144

0.17

%

Savings and money market

516,570

289

0.22

%

444,702

240

0.21

%

Time deposits – under $100

21,707

16

0.29

%

20,681

15

0.29

%

Time deposits – $100 and over

212,201

251

0.47

%

206,909

173

0.33

%

Time deposits – brokered

4,874

10

0.82

%

24,861

50

0.80

%

CDARS – money market and time deposits

8,256

1

0.05

%

16,678

1

0.02

%

Total interest-bearing deposits

1,278,904

826

0.26

%

1,040,753

623

0.24

%

Total deposits

2,121,469

826

0.15

%

1,693,282

623

0.15

%

Short-term borrowings

55

–

0.00

%

166

–

0.00

%

Total interest-bearing liabilities

1,278,959

826

0.26

%

1,040,919

623

0.24

%

Total interest-bearing liabilities and demand,

noninterest-bearing / cost of funds

2,121,524

826

0.15

%

1,693,448

623

0.15

%

Other liabilities

50,384

48,494

Total liabilities

2,171,908

1,741,942

Shareholders’ equity

259,395

214,105

Total liabilities and shareholders’ equity

$

2,431,303

$

1,956,047

Net interest income(2) / margin

23,354

4.10

%

19,989

4.39

%

Less tax equivalent adjustment(2)

(306

)

(306

)

Net interest income

$

23,048

$

19,683

(1)Includes loans held-for-sale. Yield amounts earned on loans include loan fees and costs. Nonaccrual loans are included in average balance.

(2)Reflects tax equivalent adjustment for tax exempt income based on a 35% tax rate.

For the Nine Months Ended

For the Nine Months Ended

September 30, 2016

September 30, 2015

Interest

Average

Interest

Average

NET INTEREST INCOME AND NET INTEREST MARGIN

Average

Income/

Yield/

Average

Income/

Yield/

(in $000’s, unaudited)

Balance

Expense

Rate

Balance

Expense

Rate

Assets:

Loans, gross(1)

$

1,409,637

$

59,235

5.61

%

$

1,136,208

$

48,360

5.69

%

Securities – taxable

500,497

8,004

2.14

%

230,608

4,828

2.80

%

Securities – tax exempt(2)

92,194

2,651

3.84

%

84,286

2,444

3.88

%

Federal funds sold and interest-bearing

deposits in other financial institutions

195,850

1,478

1.01

%

171,503

1,070

0.83

%

Total interest earning assets(2)

2,198,178

71,368

4.34

%

1,622,605

56,702

4.67

%

Cash and due from banks

32,927

28,647

Premises and equipment, net

7,638

7,388

Goodwill and other intangible assets

53,641

20,721

Other assets

83,574

73,417

Total assets

$

2,375,958

$

1,752,778

Liabilities and shareholders’ equity:

Deposits:

Demand, noninterest-bearing

$

800,049

$

578,117

Demand, interest-bearing

505,442

731

0.19

%

265,095

349

0.18

%

Savings and money market

506,998

829

0.22

%

403,385

623

0.21

%

Time deposits – under $100

22,534

48

0.28

%

19,812

45

0.30

%

Time deposits – $100 and over

212,300

660

0.42

%

202,512

485

0.32

%

Time deposits – brokered

9,503

59

0.83

%

26,578

157

0.79

%

CDARS – money market and time deposits

8,344

5

0.08

%

13,711

5

0.05

%

Total interest-bearing deposits

1,265,121

2,332

0.25

%

931,093

1,664

0.24

%

Total deposits

2,065,170

2,332

0.15

%

1,509,210

1,664

0.15

%

Short-term borrowings

601

12

2.67

%

80

–

0.00

%

Total interest-bearing liabilities

1,265,722

2,344

0.25

%

931,173

1,664

0.24

%

Total interest-bearing liabilities and demand,

noninterest-bearing / cost of funds

2,065,771

2,344

0.15

%

1,509,290

1,664

0.15

%

Other liabilities

56,325

47,757

Total liabilities

2,122,096

1,557,047

Shareholders’ equity

253,862

195,731

Total liabilities and shareholders’ equity

$

2,375,958

$

1,752,778

Net interest income(2) / margin

69,024

4.19

%

55,038

4.54

%

Less tax equivalent adjustment(2)

(928

)

(855

)

Net interest income

$

68,096

$

54,183

(1)Includes loans held-for-sale. Yield amounts earned on loans include loan fees and costs. Nonaccrual loans are included in average balance.

(2)Reflects tax equivalent adjustment for tax exempt income based on a 35% tax rate.